Pegged currency


On Schweser Book 3 p.29 there’s a comment about the relationship between FX and interest rates. Can anyone clarify it?

Relative bond yields, both nominal and real, increase with strong economic activity and increasing demand for funds.

Assume that there are only two countries in the world: England and Australia.

Currently, the bond yields in Australia may be higher than that of England.

If the bond yields in England start increasing, more Australian investors might start investing in bonds in England.

In order to execute this investment, they will require Sterling Pounds.

The increased demand for Sterling Pounds will result in its appreciation relative to the Aussie Dollar.

Similarly, if Australian bond yields start going up, British investors will flock to Australian bonds. This will drive up the demand for Aussies, thereby resulting in its appreciation relative to the Sterling.

Hope this helps.

if you want a real curve ball, toss in the effects of inflation too.